On a liquidation and dissolution (“L&D”) of FA1, it distributed to its parent (ACo) its shares of (wholly-owned) FA2 and FA3 and other property. Ss. 88(3) to (3.5) applied to the L&D. As it was not a “qualifying liquidation and dissolution,” the FA1 properties were disposed of at their fair market value. Prior to the L&D, FA2 and FA1 had paid exempt dividends to FA1 and ACo, respectively. But for s. 93(4), Canco realized a capital loss of $1 million (after the application of s. 93(2.01) to reduce such capital loss by the exempt dividends previously paid by FA1) on its disposition of the FA1 shares. Since the FA2 and FA3 shares were acquired by ACo prior to FA1’s dissolution, did s. 93(4) apply? The Directorate responded:

ACo acquired the shares of FA2 and FA3 as part of the process of liquidating and dissolving FA1, which included ACo disposing of its shares of FA1. In our view, the distribution of the property of FA1 to ACo was “on” the disposition of the shares of FA1.

Consequently, ACo’s otherwise determined capital loss of $1 million on the disposition of its FA1 shares is deemed by paragraph 93(4)(a) to be nil. The denied capital loss is added by paragraph 93(4)(b) to the ACB to ACo of the shares of FA2 and FA3 that ACo acquired on the disposition in proportion to their respective fair market values.

What is the CRA position on Descarries? After noting that the case was not appealed because in the result it was favourable and it was only an informal procedure case, CRA then summarized the facts, stating that the Oka shareholders engaged in "three avoidance transactions" (TaxInterpretations translation) for appropriating the surplus of Oka which, in December 2004, had already " ... and was in the course of liquidating the remainder of its assets:"

First, on March 1, 2005, there was an internal rollover of their shares in the capital stock of Oka in order to crystallize in the adjusted cost base ("ACB") of new shares, the excess of the fair market value ("FMV") of the transferred shares over their ACB, thereby realizing a capital gain in respect of which the capital gains deduction in section 110.6 was not claimed.

The second transaction, effected on March 15, 2005, was to roll those new shares in the capital stock of Oka to a new corporation (9149-7321 Quebec Inc., hereafter « Quebec Inc. ») in exchange for shares of two classes in the capital of Quebec Inc.: the first class of shares having a low PUC and an ACB equal to their FMV (the "1971 FMV Shares") and the second class of shares having a high PUC (which was the purpose of the second transaction) and a high ACB equal to their FMV (the "Stripping Shares").

The third transaction was to redeem for cash on March 29, 2005 all of the Stripping Shares, and part of the 1971 FMV Shares, so as to generate a capital loss sufficient to eliminate the capital gain generated in the first transaction.

The CRA continues of the view that ITA subsection 84(2) should have applied in this case especially by reason of …MacDonald… . Furthermore, the CRA is concerned by the approach adopted by the TCC respecting the analysis of the avoidance transactions for purposes of the application of ITA subsection 245(2).

Respecting its s. 84(2) concerns, CRA noted the broad wording of s. 84(2), that the funds received on the redemption of the shares of Quebec Inc. "corresponded closely in dollars to the advance which was provided to Quebec Inc. by Oka," so that , paraphrasing RMM, the funds in the shareholders hands "were actually the funds of Oka, notwithstanding the interposition of Quebec Inc.," and that the "restrictive interpretation" accorded by Hogan J to the word "on" was inconsistent with the meaning of "as a result of" suggested in David, where there was a delay of five months. As for any potential double taxation arising from the applicability of s. 84(3), in practice CRA would avoid double taxation through applying s. 248(28)(a).

After also articulating its concerns about the decision's GAAR analysis, CRA concluded that it will seek a decision of the Federal Court of Appeal or the Supreme Court of Canada:

…confirming the broad scope of subsection 84(2) recently established….in… MacDonald …and, also, whether or not there is a specific scheme under the Act for taxing any direct distribution of surplus of a Canadian corporation as taxable dividends in the hands of individual shareholders; as well as a specific scheme under the Act against indirect surplus stripping.

David v. The Queen, 75 DTC 5136, [1975] CTC 197 (FCTD)

Approximately four months after the corporation of which the taxpayers (the "David group") were shareholders sold its principal business assets, the taxpayers sold their shares of the corporation to the corporation's pension plan (acting through the "Dunn group"), with the individuals associated with the pension plan then causing a distribution of the assets of the corporation.

Walsh J. concluded that although the payments made to the taxpayers were "made to them in an indirect manner as a result of actions taken by third parties over whom the David brothers had no control, the end result was nevertheless that it was the funds of the company, including its undistributed income, which were used to pay for their shares and that the words 'otherwise appropriated in any manner whatsoever to or for the benefit of one or more of its shareholders' are wide enough to cover what took place".

Respecting the issue as to whether this appropriation occurred 'on' a winding-up, discontinuance or reorganization of a business (which after the August sale was that of an investment company), Walsh J. stated (at p. 5148) "that if any meaning is to be given to the word 'on' it must at the very least mean at the 'same time as' or possibly 'as a result of' or 'consequential to', and went on to find that even though it was "not at the time of or 'on' the discontinuance of the commercial operations of the company in August that the funds were appropriated for the benefit of the David group but only five months later", it nonetheless was "evident that the Dunn group planned to wind-up not only the commercial but all business of the company immediately after they took over, so that a winding-up was part of the plan." Accordingly, s. 81(1)(b) of the pre-1972 Act (similar to what now is s. 84(2)) applied to the amounts received by the taxpayers.

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